Moreover, with the shares hitting a multi-year high of 72p this morning post-results, a rally back to the eight-year old all-time high of 76p, and beyond, looks a very realistic possibility, and I am very comfortable maintaining my positive stance with Sanderson shares priced on a bid-offer spread of 70p to 72p.
As regular readers of my columns will be aware, it's a business I have been following closely for the past couple of years, having initiated coverage when the price was 33.5p ('A valuable stock check', 18 Jul 2011). My 60p target price was duly achieved last month when the company announced a very smart-looking acquisition. It was also one that prompted me to upgrade my target on the shares from 60p to 70p. And following today's release, I am upgrading my target again to 80p. I have good reason, too.
e-commerce driving growth
Not only is Sanderson attracting new business, but margins are on the rise, too; gross margins increased by four percentage points to 87.6 per cent on revenues of £13.83m (from £13.37m in 2012) in the financial year to end-September 2013, driven by higher margin proprietary software. The value of contracts signed with 14 new customers during the 12-month period rose by 10 per cent to £1.6m, or 12 per cent of the total, partly reflecting an increase in sales capacity, but also ongoing product development, especially in mobile, that extends the company's proprietary software to smart phones and tablets.
It's only fair to assume these trends will continue in the future given that e-commerce sales in Sanderson's multi-channel retail segment increased by 10 per cent to £2.6m in the 12-month period to account for 36 per cent of the division's revenues.
To recap, Sanderson works in partnership with clients to deliver e-commerce software systems that underpin their online operations and enable them to cross-sell and upsell products, offer a '3D' secure payment process and integrate online offerings with other parts of their business. It's a fast-growing segment of the retail sector, too; analysts at IMRG, the industry association for e-retail, and consultancy Capgemini estimate that UK online sales will grow by around 12 per cent in 2013. Experts at Forrester predict the e-commerce segment will grow at a compound annual growth rate of 10 per cent a year out to 2017.
It's well worth noting too that m-commerce sales are underpinning e-commerce growth and this can only gain traction as customers adapt their businesses. Strategically, Sanderson's ongoing investment in proprietary software for mobile devices makes a lot of sense; m-commerce now accounts for 10 per cent of the sales, having rocketed in the past 18 months. According to technology analysts at investment bank Morgan Stanley, mobile users will exceed desktop users for the first time next year, which adds weight to the prediction by Verdict Research that m-commerce will drive e-commerce sales up by 50 per cent over the next five years.
Strong sales growth for Sanderson
Given these positive drivers, we can expect a strong pick-up in both revenues and profits in the current financial year and beyond, as benefits of some hefty recent investments pay off. In fact, analysts at both Charles Stanley and WH Ireland both expect revenues in the current financial year to ramp ahead up to around £16m, driving pre-tax profits up from £2.2m in the year just ended to £2.7m. On this basis, WH Ireland is expecting underlying EPS of 4.5p, up around 10 per cent year-on-year. The earnings figure has been adjusted to take into consideration an institutional placing which raised £3.5m at 55p a share last month following Sanderson's acquisition of One iota, a provider of mobile applications for retailers including Thorntons, Littlewoods and Superdry.
The acquisition should integrate easily into Sanderson's existing e-commerce operations and help the business expand further into mobile applications, win new customers, and provide the latest mobile technologies to its existing clients. The fund-raising helps fund the integration of One iota's MESH technology, a cloud-based technology that integrates existing back office systems to optimise a retailer's applications, with existing Sanderson e-commerce solutions; accelerate the development of Sanderson mobile solutions business; and increase sales and marketing activities. It looks a sensible deal as I understand the aim is to raise One iota's sales from £665,000 last year to around £1m within the next 12 months, and with the benefits of ongoing organic growth and being part of a much bigger company, the unit has potential to generate profits in the range £250,000 to £350,000, according to finance director Adrian Frost. That seems a realistic prediction because by leveraging off Sanderson's balance sheet strength and plc status, One iota should be able to close new business deals that previously might not have been possible due to its smaller size.
The One Iota acquisition is part of Sanderson's planned strategy to boost exposure to e-commerce in it's multi-channel retail division and follows hot on the heels of the acquisition in August of e-commerce solutions company Catalan in a £500,000 deal. That looks smart, too as, according to Mr Frost, Catalan's annualised cash profits are running at a run rate of around £120,000 and there is scope to lift profits to £150,000 on sales of £1m.
Profit forecasts well underpinned
In order for Sanderson to achieve pre-tax profits of £2.7m in the current financial year as analysts expect, the company needs to lift revenues by 16 per cent to £16.1m. Of this sales figure, £8.5m is already recurring, the company has a £1.9m order book and the Catalan and One Iota acquisitions should be able to contribute annualised revenues of around £1m each by this time next year. Factor in the growth of e-commerce and m-commerce segments, and that sales forecast does not look unrealistic to me.
Moreover, analyst forecasts of a £500,000 profit uplift this year don't look stretched at all once you factor in the contribution from One iota and Catalan. The deals were well structured, too, as the £5.43m paid for One iota included £2m of the deferred consideration-dependent performance targets being achieved over the next three financial years. On this basis, the acquisition is priced at less than 10 times operating profit on the initial consideration and 16 times including the deferred consideration. But with only 55 per cent of the consideration payable upfront, the deferred payments have been structured in such a way that effectively pays for roughly three-quarters of the consideration itself. That's smart.
Sanderson rated below peers
Despite the fact that some of Sanderson's businesses are operating in high growth areas, the company enjoys high quality recurring revenues worth 57 per cent of total sales and boosts a strong order book, the shares are not highly rated.
In fact, strip out net cash of £4.5m, worth 9p a share, from the current share price and the company is being rated on a prospective PE ratio of 14, a hefty discount to the software and computer services sector average of 19. The valuation discrepancy is even wider compared to companies like Brady (BRY) and Craneware (CRW), both of which trade on well above 20 times earnings.
There is a decent dividend, too, as analysts expect the full-year payout for the 12 months to end-September 2014 to be raised to 1.6p a share, having just been raised by 25 per cent to 1.5p in the year just ended. On this basis, the shares offer an attractive prospective yield of 2.2 per cent. This compares favourably to the FTSE Aim Technology index yield of 0.5 per cent.
So, with Sanderson's profits continuing on an upward trajectory, and scope for the company's manufacturing business to boost growth this year, helped by demand from the food and beverage segment, I see no reason why the shares should not continue their rerating. Offering a unique combination of growth, yield and exposure to the retail and manufacturing markets, I am upgrading my target price from 72p to 80p and await the next trading update at the annual meeting at the end of February. Buy.
Finally, I have written two columns today, both of which appear on my home page. In response to recent newsflow, I am currently working my way through a large number of updates on the following recommendations: Bezant Resources (BZT), PV Crystalox Solar (PVCS), Crystal Amber (CRS), API (API), Mountview Estates (MTVW), Daejan (DJAN), Bovis Homes (BVS), WH Ireland (WHI), Netcall (NET) and Pilat Media Global (PGB).
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